Bond Insurance

Bond insurance (also known as "financial guaranty insurance") is a type of insurance whereby an insurance company guarantees scheduled payments of interest and principal on a bond or other security in the event of a payment default by the issuer of the bond or security. As compensation for its insurance, the insurer is paid a premium (as a lump sum or in installments) by the issuer or owner of the security to be insured. Bond insurance is a form of "credit enhancement" that generally results in the rating of the insured security being the higher of (i) the claims-paying rating of the insurer and (ii) the rating the bond would have absent insurance (also known as the “underlying” or “shadow” rating).

The premium requested for insurance on a bond is a measure of the perceived risk of failure of the issuer. It can also be a function of the interest savings realized by an issuer from employing bond insurance or the increased value of the security realized by an owner who purchased bond insurance.

Insured securities range from municipal bonds and infrastructure bonds to asset-backed securities (“ABS”), such as residential mortgage- backed securities (“RMBS”) and collateralized debt obligations (“CDOs”) domestically and abroad.

The economic value of bond insurance to the governmental unit, agency, or other issuer offering bonds or other securities is a saving in interest costs reflecting the difference in yield payable on an insured bond from that on the same bond if uninsured. The economic value of bond insurance to the investor purchasing or holding insured securities is based upon (i) the additional payment source provided by the insurer if the issuer fails to pay principal or interest when due (which reduces the probability of a missed payment to the joint probability that both the issuer and insurer default), (ii) rating downgrade protection so long as the insurer is more highly rated than the issuer, (iii) improved liquidity, and (iv) services provided by the insurer such as credit underwriting, due diligence, negotiation of terms, surveillance, and remediation.

Bond insurers generally insure only securities that have underlying or shadow ratings in the investment grade category, with unenhanced ratings ranging from “triple-B” to “triple-A.” Beginning in the 1970s, municipal government bonds were insured by bond insurers, also known as the “monolines.” The global financial crisis of 2008 seriously harmed their business model, to the point where the continued operation of a number of bond insurers is in doubt.